While most of your investment decisions should be based on the principle that you should invest in companies that are generating consistent cash flow at reasonable valuations, this can become boring. For some people that’s fine, but for others there needs to be another element of excitement to the investment process. It follows that if you want to — and if you can afford to — you can speculate with some of your money.
Speculation, as opposed to investing, is betting on a company that doesn’t have a cash flow stream that is looking for one. It could be a small mining company exploring for gold or a drug company looking for the next weight-loss pill or a cure for cancer. These companies don’t have a clearly visible cash flow stream in the future, and so there is a risk that they will go bankrupt or dilute shareholders to the point that each share is worth just a small portion of the company.
The good news is that such companies are often inexpensive relative to their cash flow potential. That is, if these companies find the cash flow streams that we are hoping for, then their valuations can skyrocket to many multiples of their current market capitalizations.
Speculation is just that — you’re betting on something that isn’t there, and therefore you are gambling. But just like card counting, you can do things to skew the odds into your favor, and in effect, you can speculate intelligently. Here are some tips for doing so.